Providers of products and services face many challenges in marketing their respective products and services in a market-based economy. Because different consumers typically value the same product or service differently, one challenge for a provider is to distinguish between those consumers who place a higher value on a product or service from those consumers whose subjective valuation of the product or service is lower.
One technique for enlarging a provider's “producer surplus” is price discrimination. With price discrimination, those consumers whose subjective valuation of a product or service is higher are charged a higher price, while those consumers who place a lower value on a product or service are charged a lower price. Price discrimination can be effected, for example, using product lines, according to which different versions of the same basic product are offered by varying one or more attributes of the product. For example, a linen seller might offer multiple versions of bed sheets by varying the thread count so that a higher price could be obtained from consumers desiring a 500-thread count than that obtained from consumers who are content with only a 250-thread count. Accordingly, product lines can allow a seller to achieve higher unit sales (e.g., by allowing the seller to attract low-valuation customers) and/or allow the seller to generate higher average revenue per sale (e.g., by inducing high-valuation customers to pay higher prices.) The same technique can be applied in order to achieve price discrimination in the context of providing a particular service.
One disadvantage of product lines, however, is that compared to single products, multiple products can be much more expensive to create and sell. This primarily is because offering a product line with different versions of the same underlying product (e.g., sheets having different thread counts) requires separate design, manufacturing, marketing, and distribution processes for each of the products in the line. Another disadvantage to attempting to achieve price discrimination by offering a product line is that the strategy can diminish the producer's ability to benefit from economies of scale. For example, if unit cost declines with output, then producing 2,000 bed sheets that have a 500 thread count may be less costly than producing 1,000 units with a 500-thread count and 1,000 units with a 250-thread count.
Other mechanisms for price discrimination include techniques such as offering coupons, rebates, volume discounts, and/or senior discounts. Each of the mechanisms, however, has its own limitations or disadvantages. For example, senior discounts unnecessarily and likely sub-optimally provide discounts even to those seniors who are not sensitive to the product's price.
Another challenge facing product and service providers is demand uncertainty. The problem arises because it is often difficult for the producer to accurately predict future consumer demand for a particular product or service. If demand is unknown, the producer is more likely to sub-optimally set the asking price for the product or service. For example, a seller of handbags would ordinary prefer to set a higher price for handbags of a certain type or style that is likely to be this season's more fashionable one, while setting a lower price for less fashionable versions. Without being able to predict which version will be more fashionable, however, the seller's ability to set an optimal price at the outset is significantly constrained.
Moreover, when a seller has limited capacity, demand uncertainty can result in too much or too little of a product being produced or inventoried. In the event of the former, the seller typically endures the expense of producing unsold goods and possibly the cost of carrying excess inventory, whereas the latter event denies the seller the opportunity to fully exploit current market demand.
Various mechanisms for dealing with demand uncertainty have been proposed. For example, the airline industry has implemented sophisticated yield-management systems in an attempt to adjust prices over time so as to obtain the maximum revenue given a limited number of seats available for any particular flight. Nonetheless, the mechanisms are typically quite costly to design and implement.
Accordingly, there is a need for more effective and efficient mechanisms for dealing with these and other challenges facing product and service providers operating in a market-based economy.